Final Fantasy Tactics: The War of the Lions

It is based on the highest level of everyone in your formation screen, even those who are not currently in battle.

I'll just give more detail.

enemy's levels in random battles are based on the highest-leveled character in your party, even if you don't deploy that character in the battle.
it includes human characters, guests and monsters.

In random battles the monster's levels are based off of your highest level charecter. If your strongest level charecter is level 56 then all random enemies will be near 56.

For story battles all enemy levels are already made. They don't change based off of your party.

Story Battles:
Human characters have a fixed level. Monsters' level are based on you roster's average level.

Random Field Battles:
Monsters and Human Characters have their level based on your roster's average level.

Note that on story battles, the gear enemies wear are proportional to their level. You won't see a level 30 Knight with a Excalibur or something =/

Haha Lv 30 Knight w/ an Excalibur xD

Anyways cepheux is correct ^^ except for the "roster's average level" thingy. All enemies' average levels in random battles will be based off of the level of your highest-leveled character whether it is an ordinary member, secret chars, main chars, guests or monsters.